Shipbuilding bank guarantee battle - NSW Supreme Court allows call on bank guarantee amidst an ongoing US$1bn arbitral dispute over FPSO construction
In the recent decision of Daewoo Shipbuilding & Marine Engineering Co Ltd v Inpex Operations Australia Pty Ltd  NSWSC 1125, the NSW Supreme Court held that a party will not, prima facie, be precluded from calling upon a bank guarantee for the sole reason that arbitral proceedings have been commenced and are pending determination.
Daewoo Shipbuilding & Marine Engineering Co Ltd (Daewoo) is a Korean shipbuilding company. Inpex Operations Australia Pty Ltd (Inpex) is the Australian subsidiary of a Japanese company that operates the Ichthys Gas Field Development Project (Project).
The Project involves the extraction of hydrocarbons from the Ichthys Gas field, located some 220 km offshore from north-western Western Australia in the Timor Sea. The hydrocarbons are converted into natural-gas condensate through a semi-submersible platform, and then transferred to a floating production storage and offloading (FPSO) facility, by which the condensate is processed, stored, and exported.
In March 2012, Daewoo and Inpex entered a contract that required Daewoo to construct and deliver the FPSO, to particular standards and within a specified timeframe.
The contract included several warranties and, relevantly, a detailed provision regarding Daewoo’s obligation to provide a bank guarantee to guarantee the due performance of its work, the circumstances in which Inpex was entitled to have recourse to it, and a contractual waiver of Daewoo’s right to seek injunctive relief to prevent Inpex calling on the bank guarantee, except in limited circumstances.
In April 2012, a bank guarantee was issued by a Korean bank for approximately US$328m.
A dispute arose when Inpex claimed losses because of Daewoo’s alleged delays and defects in its work. Inpex referred the dispute to arbitration pursuant to the contract’s dispute resolution clause.
Inpex claimed recourse to the guarantee to pay for the losses claimed. The total losses claimed exceeded the amount of the guarantee and were recently reported as being in the order of almost US$1 billion (approx. US$974m).
Daewoo obtained urgent interlocutory relief, on an ex parte basis, restraining Inpex from calling on the guarantee. Inpex filed a cross-summons seeking, in effect, confirmation of its entitlement to call on the guarantee.
Daewoo filed a motion seeking an order that the cross-summons be stayed pursuant to section 7(2) of the International Arbitration Act 1974 (Cth) (IAA), and that the parties be referred to arbitration.
The interaction between international arbitration and Court proceedings
In Australia, the IAA gives effect to the UNCITRAL Model Law (Model Law), which is given force of law in Australia. The regime is broadly like the uniform Commercial Arbitration Acts in each Australian State and Territory.
Section 7(2) of the IAA provides that where an arbitration agreement exists, a Court must stay the proceedings and refer the parties to arbitration unless the Court finds the agreement null, void, or incapable of being performed.
Article 9 of the Model Law makes clear a party can resolve a dispute through arbitration and, at the same time, seek assistance from the Court for interim protection orders. Further, Article 17 of the Model Law provides that a Court has the same power in issuing interim measures as it has in relation to proceedings in Courts. As such the same general principles that apply in Australia to the grant of interim injunctions are relevant, albeit having regard to special features of international arbitration.
A special feature of international arbitration is that a Court should respect the parties’ choice to arbitrate and not take out of the hands of the arbitrators something which the parties have entrusted to the arbitrator alone to decide upon. Here the arbitration clause permitted the parties to seek “urgent relief” but did not specifically refer to interim or interlocutory relief. Similar cases have regarded the seeking of “urgent relief” as a “carve out” to the arbitration agreement, such that it falls outside of the Court’s obligation to stay proceedings that were being arbitrated. The Court held there was no impediment to the Court granting interim measures and it was not obliged to stay the proceedings before doing so.
Daewoo was required to satisfy the Court that:
- there was a strong prima facie case justifying the Court’s interference; and
- a balance of convenience analysis favoured the granting of the injunction.
Limb 1 – was there a strong prima facie case?
As to the first limb, the Court identified the following general principles:
- The Court’s approach to determining interim measures is to be treated no differently where the parties have agreed to arbitrate.
- The Court must consider whether the bank guarantee was intended to allocate risk pending the final determination of the parties’ rights.
- A prima facie case is not ‘one size fits all’. It may be necessary for the Court to construe the contractual provisions. To do so is consistent with Article 17J of the Model Law. This should not be taken as binding on the arbitral tribunal, but simply what the Court needs to do to satisfy itself that it should preserve the status quo until the arbitral tribunal can finally determine the matter.
Daewoo’s prima facie case was asserted on three grounds:
- The warranty period during which the bank guarantee was able to be called upon had expired;
- Inpex was in breach of a negative covenant preventing it from calling upon the bank guarantee during a period when it was required to release; and
- Daewoo’s contractual waiver to seek injunctive relief was an attempt to oust the jurisdiction of the Court, and as such in breach of public policy and unenforceable.
Inpex argued the bank guarantee acted not solely as security, but also as a risk allocation agreement. As such, the issue was whether there was a serious question to be tried as to whether Inpex was in breach of this risk allocation agreement. It argued there was no implied negative covenant, that the parties intended that Inpex would have a right to call on the bank guarantee as long as there was a legitimate dispute, and in the alternative that the warranty period under the contract had been extended. Even if the Court found that there was a serious question to be tried, Inpex argued the injunction should be refused as a matter of discretion, as Daewoo’s case, while reasonably arguable, was weak.
Relying on an earlier judgment that had construed the exact same contractual terms, the Court held the bank guarantee acted as a “risk allocation device”, providing a ‘pay now, argue later’ regime. The contractual bargain of the parties was that, while the contest is resolved before an arbitral tribunal, Inpex “gets to hold the money”.
While the Court found that Daewoo’s contentions were arguable, the Court was not satisfied that Daewoo had a prima facie case of sufficient strength to warrant the continuation of the interim injunction.
Limb 2 - balance of convenience analysis
If wrong on the first limb, the Court when on to consider the second limb. This assessment focused on whether the inconvenience that Daewoo would likely suffer if an injunction were refused outweighed the injury which Inpex would have suffered if an injunction was granted.
Daewoo submitted that the balance of convenience favoured the grant of the injunction, where it undertook to extend and maintain the bank guarantee, together with the usual undertaking as to damages. If the injunction was not granted, it should be inferred that Inpex would call on the guarantee, with profound financial and reputational consequences to Daewoo.
Daewoo cited experiencing financial troubles in recent times, in particular, because of COVID-19 and international sanctions imposed on Russia following its invasion of Ukraine. Despite acknowledging that when agreeing to give a bank guarantee a decade ago, Daewoo could not have foreseen such events, the Court was not satisfied that the balance of convenience favoured the extension of the interlocutory injunction. The Court observed that Inpex did not agree to take on a risk that it would lose its right to call on the bank guarantee during periods of dispute, nor take on further risks associated with Daewoo’s financial difficulties or potential insolvency.
There have been many judgments of the High Court and state and federal appellate Courts concerning bank guarantees in construction projects. Less clear was how these principles are to be applied where the parties have agreed to arbitration.
The decision clarifies the ‘apparent’ divergence of Australian jurisprudence as to the treatment of guarantees where arbitral proceedings are ongoing. It solidifies the position that a guarantee can be called upon and retained by the party entitled to call upon it, while the parties await the final resolution of their dispute by an arbitral tribunal.
Parties considering calling upon a guarantee should carefully review the provisions of the relevant contract, to ensure that there is a sufficiently strong basis for calling upon a guarantee. A party’s ability to retain the guarantee pending a final outcome will largely turn on the relevant provisions of the contract in question.
This article was co-authored by Myumee Hossain, Paralegal.